Is Bitcoin Deflationary? Inflationary?

In the comments on one of the Bitcoin posts, someone posited that Bitcoin is deflationary. Other posts on Bitcoin that I have seen have said similar. Others worry it might be inflationary, since it’s easily divisible.

It’s neither and here is why.

What causes inflation in fiat money? It’s not printing more money. Since 2008, the Federal Reserve has created more money than ever before in our history and we don’t have inflation. We do have the kindling laying around for inflation. If you spoke with the Fed, they’d like to see a little inflation!

Here is what causes inflation:

1. Demand pull. When an economy is at full employment and has too few dollars chasing too few goods. Prices rise. This could also be describes as a rise in demand relative to supply. Once the supply curve changed and demand was met, prices could drop.
2. Market power. If a company can raise prices without worrying about competition, inflation could result.
3. Supply shock. For some reason, the supply chain is disrupted changing the supply curve and prices rise.

Could this happen in Bitcoin? Yes. There could be situations where demand exceeds supply and miners can’t mine Bitcoin fast enough. That could drive prices higher. To correct that, Bitcoin can be decimalized, but that won’t happen overnight. Supply and demand shocks take a little time to work themselves out.

What about deflation? Deflation is incredibly scary to macroeconomists. Unbridled deflation can lead to incredible economic disruption. The 1930′s Great Depression saw deflation. It’s not pretty.

But, Bitcoin isn’t deflationary either. Here are some causes of deflation.

1. High unemployment. People cannot afford to purchase goods and services because they don’t have money.
2. Increased productivity. When we get more efficient at production, the costs to production go down decreasing the costs to consumers.
3. Decreases in the Supply of Currency can cause deflation. This causes interest rates to rise and credit to get constrained. Ironically, the best and quickest cure for inflation is increased interest rates.
4. Heavy taxes. The more a government taxes, the less disposable income people have to spend.
5. Large public debt. Governments borrowing transfer money from the general public to the government and also are a pledge against future public income.

Factors one and two could affect Bitcoin valuation.  There is no decrease in the supply, since supply is fixed.  Currently, there are still Bitcoins to be mined, so supply is expanding.  Factors four and five could have nominal effects on the value of Bitcoin the same as they do any currency.  But, if one government raises taxes, it’s not going to have a 1:1 correlation with the value of Bitcoin.

The long term value of Bitcoin will be “relative to x”. Even more likely, the value will be “relative to x,x,x,x,x,x,x,”.  Bitcoin will have an exchange rate with all the fiat currencies, and with other cryptocurrencies yet to be invented.  The free market will determine the value of Bitcoin.

It won’t exist in a vacuum the way it does today. Bitcoin’s value will float. It will look a lot like a fiat currency does today-except there is a fixed supply line for the total amount of Bitcoins. Only 21 million exist.

Knowing that, it means that as Bitcoin changes in price relative to other curencies, decimalization will be the only way to account for changes in the price of goods and services. But, that price will go up and down responding to all the supply and demand forces that the free market places on goods and services. Bitcoin won’t be different than any other good or service invented by man since the beginning of time.

Related articles

• Bitcoin Isn’t A Currency: Ernst & Young
• Why I want Bitcoin to die in a fire
• Bitcoin Calculator: How Much is Your Wallet Worth?
• Why won’t Bitcoin die?

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